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Microsoft’s Failed Yahoo Bid Risks Online Growth

Steven A. Ballmer, Microsoft’s chief executive, walked away from a Yahoo deal on Saturday still looking for an answer to his company’s fundamental problem: its time-tested recipe for success isn’t working against Google, the leader in the current wave of Internet computing.

With a bid for Yahoo, Microsoft was trying to buy its way out of the problem. It was a controversial step and a gamble, but at least it was a big move. Now, there is no clear prospect of a quick fix for Microsoft, as the center of gravity in computing continues to move away from the personal computer, Microsoft’s stronghold, and to the Internet.

Microsoft remains a powerful company, and highly profitable, but its stock price has stagnated amid doubts about future growth. Years of antitrust scrutiny have tempered its competitive behavior in new markets.

Mr. Ballmer, 52, must lead the Internet-era shift in strategy and corporate culture without the man who, to many, is still the public face of Microsoft. Bill Gates, the company’s cofounder, chairman and largest shareholder, who hired Mr. Ballmer 28 years ago, is stepping away from day-to-day work at Microsoft in July to focus on philanthropy.

“Steve Ballmer will be defined by how he manages this tremendous Internet transformation over the next few years, and his record hasn’t been distinguished so far,” said George F. Colony, chief executive of Forrester Research, a technology research firm.

Competitive zeal, persistence and patient investment have been crucial to Microsoft’s triumphs over the years, as it built businesses instead of buying them. The formula worked again and again, in personal computer operating systems, applications like word processors and spreadsheets, data center software, and even video game systems.

The same tactics also vanquished the challenge from the early leader in Internet browsing software, Netscape Communications, in the 1990s. But Microsoft’s campaign in the browser rivalry led to the sweeping federal antitrust suit against the company, filed in 1998, and continuing antitrust oversight in the United States and Europe.

Microsoft’s competitive behavior is more restrained these days in the aftermath of its antitrust troubles, industry veterans and analysts say. That helps to explain why Microsoft has struggled in this round of competition, especially against Google, which has leapt far ahead in markets like Web advertising.

“Microsoft’s pursuit of Yahoo and its antitrust troubles have the same root,” said Timothy F. Bresnahan, an economist at Stanford University and a former Justice Department antitrust official. “The future of mass-market computing is not the personal computer.”

Microsoft’s effort to grab Yahoo and its ultimate decision to abandon the campaign displayed the two sides of Mr. Ballmer’s business style: high-octane competitive aggression and analytical pragmatism.

Mr. Ballmer informed a startled Jerry Yang, Yahoo’s chief executive, that Microsoft would be making an unfriendly offer for Yahoo in an afternoon phone call the day before the bid was made public on Feb. 1. The stock-and-cash offer, valued at $44.6 billion, or $31 a share, was 60 percent more than what Yahoo’s shares had traded for the day before.

On April 5, frustrated by the lack of negotiations, Mr. Ballmer sent Yahoo a threatening letter, suggesting Microsoft would go directly to Yahoo shareholders for a vote if Yahoo’s management did not agree to a merger within three weeks.

But in a meeting two weeks ago with Mr. Yang, it became clear to Mr. Ballmer that he needed to reach a friendly deal or withdraw entirely, according to people close to him who attended the meeting. The small group met in downtown Portland, Ore., at the offices of the law firm founded by Mr. Gates’s father.

Mr. Yang made a lengthy presentation, using Microsoft’s PowerPoint software, that ended with a page stating, in bold letters, that Microsoft’s offer “substantially undervalues” Yahoo. But when Mr. Ballmer asked what price would value the company properly, Mr. Yang refused to even discuss the subject, according to a person at the meeting.

As the Microsoft team left, this person said, one of Mr. Ballmer’s lieutenants whispered, “They are going to burn the furniture if we go hostile. They are going to destroy the place.”

On Saturday, the two men again failed to reach an agreement on a fair price, and Mr. Ballmer walked away.

The decision also showed Mr. Ballmer’s analytic discipline; he had his number, and he wasn’t going further.

For most of his career, Mr. Ballmer has been overshadowed by Mr. Gates. Their friendship started in their days as students at Harvard University; their business partnership began when Mr. Ballmer joined Microsoft.

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Though he became chief executive in 2000, Mr. Ballmer has typically been cast as a marketing dynamo: tireless, hyperkinetic and a booming orator, renowned for his uninhibited performances at Microsoft sales meetings. But Mr. Ballmer, colleagues say, has a deep mastery of strategy and finance. He is a math whiz who as a student scored a perfect 800 on the SAT math exam.

Yet Mr. Ballmer’s business skills have not yet helped Microsoft much in trying to catch Google, analysts say. The Silicon Valley powerhouse is a smart, nimble and aggressive competitor, and the leader of a broad shift toward Internet computing.

That transition began in the 1990s, and Netscape was part of it. But the tilt toward the Internet has accelerated in recent years. People now go online from a PC or cellphone, while most of the processing and services they use are located in vast data centers run by Google, Yahoo, Amazon, Facebook and other Internet companies. Google and others have even begun offering online word processors and spreadsheets as alternatives to Microsoft’s desktop products.

Microsoft has made huge investments in the online field, but its heritage, profits and leadership come from the desktop PC software business.

Looking at Microsoft today, Mitchell Kapor, an elder statesman of modern computing, is reminded of another industry power that was chastened by a lengthy antitrust struggle and a seismic shift in the technology landscape — I.B.M. in the 1980s and early 1990s, as the mainframe gave way to personal computing.

“I.B.M. came out of those years still large and enormously important to its customers, but I.B.M. was displaced by Microsoft,” he said. “I.B.M. was no longer the defining company.”

“The irony is that what Microsoft did to I.B.M., Google is doing to Microsoft,” said Mr. Kapor, founder of Lotus Development, which made the leading spreadsheet program in the 1980s, and the founding chairman of the Mozilla Foundation, developer of the free Web browser Firefox.

In the current round of Internet competition, Microsoft must be careful to not antagonize antitrust authorities. Despite years of scrutiny, sanctions and fines, Microsoft’s lucrative business remains largely untouched. Still, analysts and rivals say, Microsoft is a more cautious competitor these days.

For example, one ingredient in Microsoft’s formula for success has been to link new software to its dominant PC operating system, Windows, either with proprietary formats or by simply bundling new software into Windows. It did that long ago with its desktop word processing and spreadsheet programs, and it used the bundling tactic most forcefully with Web browsing software in the 1990s.

Microsoft declared the browser a part of the operating system and gave it away free. The move, according to Microsoft, was done to benefit consumers. Rivals and antitrust officials saw it as a blatant tactic to stifle competition from Netscape.

This bundling strategy was a central element in the federal antitrust suit in the United States, and it has been challenged in Europe as well. The Bush administration, however, settled the federal case without restricting Microsoft’s freedom to put new products and features into Windows.

“But the legacy of the antitrust suit was to make Microsoft much more cautious about bundling for fear of reigniting the problem,” Mr. Kapor said.

In Internet search, Microsoft has not used its dominance in desktop and browser software to favor its offering called Live Search. In the upper-right corner of a Web browser window, there is typically a slender box for typing in search terms. In search, the equivalent of the bundling formula would be to send those queries to Microsoft’s search service by default.

“It could have, but Microsoft never did that with Google,” said Michael A. Cusumano, a professor at the Massachusetts Institute of Technology’s Sloan School of Management. “The antitrust process made Microsoft more restrained, and it did change the company’s culture.”

Now, without Yahoo, Microsoft may seek smaller deals or return to its traditional game plan, relying on patient investment and persistence to build a more competitive online business.

Speaking to a group of investors and analysts in 2005, Mr. Ballmer said no one should doubt Microsoft’s determination. “We will do well,” he said. “Whether it’s me or the guy who replaces me because we don’t do well. We’ll keep coming, and we will do well.”